Commentary

Spain could opt out instead of getting a bailout

Commentary: Leaving the euro isn’t so far-fetched

By

MatthewLynn

LONDON (MarketWatch) — The markets are spending a huge amount of time trying to figure out the answer to a very simple question.

When will there be a Spanish bailout — a request for emergency aid from Prime Minister Mariano Rajoy that will trigger intervention by the European Central Bank to start buying on bonds on a massive scale?

But they may have missed the real story.

Reuters

Spain's Prime Minister Mariano Rajoy promised to reject an EU bailout, and he may yet deliver on that promise.

Instead of a bailout, there could be an opt out. In other words, the Spanish might decide to quit the euro
EURUSD, -0.7836%
rather than submit to the demands of an EU-led rescue package.

Crazy? Not completely. In the election last year Rajoy promised not to seek a bailout. Investors have grown cynical about politicians’ promises, and rightly so. They get broken so often they aren’t usually worth listening to.

But it is just possible that he actually meant it — and right now, the only way he can make good on that pledge, and save his own political skin, is to start plotting for the return of the peseta.

There can be little doubt that Rajoy will avoid applying for an ECB rescue if he possibly can. The right-of-center leader took power in December last year after wining the election on a platform of avoiding the fate of Greece, Ireland and its neighbor Portugal, and being forced into a rescue from the rest of the euro zone. If he has to break that pledge, he’ll look like both a liar and a clown, and that is hardly a happy combination for anyone seeking re-election.

True, he might still get away with avoiding a bailout.

There is a slim chance the mere threat of ECB intervention will bring Spanish bond yields back down to acceptable levels. It has got them back under 6%, but that is mainly because dealers suspect the ECB may wade into the market any day, and don’t want to be on the wrong side of the trade when it happens. Delay too long and yields will spiral out of control again.

Likewise, it is possible that labor market reforms might eventually restore the competitiveness of the Spanish economy, and that its banks will eventually get all the dud property loans off their books, allowing the country to start growing again within the single currency.

Possible. But both seem very unlikely. Right now, Spain is sinking into a Greek-style depression, with escalating debts, and a shrinking economy. There is, however, one way the Spanish could avoid a bailout. They could leave the euro and restore the peseta.

That has always been an attractive option for the Spanish, more so than the other countries struggling to survive in the single currency. This was a country that had tired of authority before it had even begun; it was in Madrid that the indignados protests started last year. It had terrible unemployment — more than 20% of the workforce and 40% of young people — before the euro crisis even began. A recession is a hard thing to bear when that many people are already out of work.

On the flip side, life outside the euro zone doesn’t hold much fear for the Spanish. Unlike the Greeks, they don’t have to worry about how they will make their living in the world. Underneath the euro crisis, Spain has a robust, successful economy. It has a similar export-to-GDP ratio as the U.K. and France — about 27% — meaning it makes lots of stuff and sells it around the world.

And, rather like Britain, it has broader horizons than the euro-zone economy: Spanish companies look toward the fast-growing South American economies rather than sluggish Europe as a place to sell their goods. They are members of the single currency for largely practical reasons. If it works, great. If not, they could easily be off.

Right now, there are two extra factors that have to be added into the equation.

First, it is now clear the euro rescue packages are a road to nowhere.

The Greek economy is still shrinking rapidly two years after it was “rescued,” and is currently having to negotiate a humiliating third bailout. Portugal is back in crisis: the government has already had to back down on tax increases to try and meet the EU-imposed deficit-reduction goals, and the country is sinking into a deepening recession. Even the hyper-competitive Irish economy shows little sign of recovery two years after its “rescue.”

Who could willingly sign their country up for a program that has been demonstrated, beyond any reasonable doubt, to involve vast sacrifices for no apparent gain?

Catalonian nationalism has resurfaced, with snap elections in the region scheduled for later this year. Spain has always been a splintered nation. What happens to Catalonia’s debts should it leave Spain and declare independence? No one really knows. But it is certainly possible for opportunist local politicians to argue they should be repudiated. Regional independence parties can promise an easy way out of austerity.

A Spanish PM who asks for a bailout is risking the unity of his nation. That is a big call to make. Against that, wouldn’t the bale-out be more attractive?

After all, Spain is a competitive economy, with lots of successful companies.

If Rajoy announced he was restoring the peseta, and started touring the world’s capital markets, he’d have a good story to tell. With its own currency, and its own central bank standing behind its financial institutions, the country could devalue, restore its competitiveness at a stroke, and start taking market share from French and German rivals.

Reformed labor markets would deliver more jobs once austerity was eased. And the tourist industry would boom on the back of a cheaper peseta. It’s not a bad pitch, and certainly good enough for plenty of investors to buy into, and to start investing in the new currency.

It could be a surprising painless transition. Far-fetched? Possibly. But it is not so crazy that investors should assume the bailout is a done deal.

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